Failed Cemetery Site Tax Shelter Leads to $187K Deficiency Assessment a Decade Later for Investors

Charitable deductions can provide taxpayers with very valuable tax benefits in the form of larger deductions. In some case, though, when taxpayers invest in questionable tax deduction generating schemes, the drawbacks of these investments ultimately far outweigh the benefits. In one such instance, the US Tax Court recently upheld the Internal Revenue Service’s assessment of deficiencies of a couple’s 1996-99 tax returns, amounting to nearly $200,000. Even though the IRS notice of deficiency occurred more than a decade after the couple filed their returns, specific exceptions to the law’s three-year statute of limitations allowed the agency to assess and collect the deficiencies.

The dispute regarding several of Michael and Ruth McElroy’s federal income tax returns centered around a group of business entities (in this case, partnerships) in which the taxpayers invested. The partnerships obtained cemetery sites, held them for a period of time, and then transferred the sites to qualified charitable organizations. The objective of this process was to give investors in the partnerships large charitable contribution deductions on their taxes.

Unfortunately for the McElroys and the other investors, the partnerships did not hold the sites for the necessary length of time, meaning that the proper charitable deductions related to the sites were tied to the sites’ cost basis, rather than their assessed value. The McElroys claimed charitable contribution deductions in 1996-98 and a deduction carryover on their 1999 tax return. In 2011, the IRS notified them of tax deficiencies for their 1996-99 returns, totaling more than $187,000. The taxpayers tried unsuccessfully to persuade the Tax Court that the IRS was barred from pursuing these deficiencies by the three-year statute of limitations. The court, however, agreed with the IRS’ argument that the tax code recognizes an exception to the three-year statute of limitations for certain taxes “attributable to partnership items” under the Tax Equity and Fiscal Responsibility Act of 1982. The limitations period for partnership items can be extended if the IRS sends out the proper final partnership administrative adjustment (FPAA) documents, and an “action is begun under section 6226” of the code. Since the IRS sent FPAAs to Johnston regarding each of the partnerships prior to the three-year period elapsing, there was no statute of limitations problem implicated in the IRS’ pursuit of the McElroys’ 1996-99 deficiencies.

The taxpayers also lost their argument that they should at least be able to deduct their initial investment amounts, which had become worthless. The Tax Court again disagreed. Section 165, which governs business loss deductions, requires that the transaction must be “entered into for profit.” The tax benefits (in increased charitable donation deductions) that the scheme was intended to generate were not “profits” within the meaning of the statute. The objective of the partnerships in which the McElroys invested was to purchase sites for money and then to donate those sites for free to qualified charities. The partnerships were designed, by their very business plan, “not to realize any income or economic profit at all,” so there was no way the taxpayers could profit, within the meaning of Section 165, from their investment in those partnerships.

Tax planning can provide taxpayers with many substantial benefits, including maximizing one’s deductions. It is, however, imperative to seek capable advice about one’s tax deduction generating plans to ensure that those structures are allowable by law. The knowledgeable and reliable tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. are here to help you with your tax planning needs. They can help you craft a plan that will help you meet your needs and remain compliant with the law. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.

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